Wednesday, June 24, 2020

Network Effects

The whole business world talks about (and chases) network effects. But there is a surprising amount of misunderstanding, also and especially among early-stage investors. When I talk about our vision for I always stress the point that our business model and (future) defensibility heavily relies on network effects. More often than not what I hear from the other side of the table is something in the line of:

You don't have network effects. Network effects is something you see in social networks leading to exponential user growth."

But that is not the network effect I am talking about. That is called virality. Clearly you can use networks to create virality / exponential growth, e.g. when every user invites > 1 users to your product, but it's not what is generally meant when talking about network effects.

Here is a link to an article by nfx, that very comprehensively explains the several types of network effects. The key take-away is: when talking about network effects, keep the following definition in mind:

A company is said to show network effects if its product(s) become not less, but more valuable with usage.

(By the way: Scott Galloway calls it the Benjamin Button effect -- which I like better, as it stresses the "more valuable with time" nature more and avoids the very common above misunderstandings.)

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